Spin-Off Taxation – Current State Part II | USA

Leverage is one of the most important and complex aspects of any spin-off and a distributing “ParentCo” should consider establishing an appropriate corporate structure for a “SpinCo”, deleveraging the parent itself (and making sure it has an appropriate capital structure when the spin-off is complete) and doing that in a non-taxable fashion.

Often the first method considered is directly putting leverage on the SpinCo. Where a SpinCo borrows money and distributes that money up to the ParentCo in connection with the formation, the ParentCo is generally permitted tax-free treatment with respect to the receipt of that cash. Less common is to have the ParentCo borrow new debt and have that debt be assumable by the subsidiary.

Tax opinions have been popular for some time because the IRS is slow to give rulings. In response, the IRS has created a fast-track ruling process, a 12-week programme with certain administrative requirements. While, from a spin-off perspective, the fast-track programme is a valuable tool, there is an increasing scrutiny of and adherence to the administrative process in order to keep rulings on track.

From 2018 onwards, the IRS has made it clear that, while the active trade or business test ordinarily requires the collection of income and payment of expenses, it also understand that sometimes investment into a business does not necessarily match revenue. Sectors such as the pharmaceutical industry often see significant investment upfront and no revenue till subsequent tax years.

While this is of great interest to those looking to divest a business that is “pre-revenue”, one note of caution should be sounded with respect to a similar test in the cross-border area, specifically regarding US shareholders receiving non-US stock. The active trade or business requirement in this context requires revenue. As ever in US tax law, understanding the nuances is critical to success in large transactions.